How to buy physical goods using Bitcoin with improved security and privacy

Bitcoin has found success as a decentralized digital currency, but it is only one step toward decentralized digital commerce. Indeed, creating decentralized marketplaces and mechanisms is a nascent and active area of research. In a new paper, we present escrow protocols for cryptocurrencies that bring us closer to decentralized commerce.

In any online sale of physical goods, there is a circular dependency: the buyer only wants to pay once he receives his goods, but the seller only wants to ship them once she’s received payment. This is a problem regardless of whether one pays with bitcoins or with dollars, and the usual solution is to utilize a trusted third party. Credit card companies play this role, as do platforms such as Amazon and eBay. Crucially, the third party must be able to mediate in case of a dispute and determine whether the seller gets paid or the buyer receives a refund.

A key requirement for successful decentralized marketplaces is to weaken the role of such intermediaries, both because they are natural points of centralization and because unregulated intermediaries have tended to prove untrustworthy. In the infamous Silk Road marketplace, buyers would send payment to Silk Road, which would hold it in escrow. Note that escrow is necessary because it is not possible to reverse cryptocurrency transactions, unlike credit card payments. If all went well, Silk Road would forward the money to the seller; otherwise, it would mediate the dispute. Time and time again, the operators of these marketplaces have absconded with the funds in escrow, underscoring that this isn’t a secure model.

Lately, there have been variousservices that offer a more secure version of escrow payment. Using 2-of-3 multisignature transactions, the buyer, seller, and a trusted third party each hold one key. The buyer pays into a multisignature address that requires that any two of these three keys sign in order for the money to be spent. If the buyer and seller are in agreement, they can jointly issue payment. If there’s a dispute, the third party mediates. The third party and the winner of the dispute will then use their respective keys to issue a payout transaction to the winner.

This escrow protocol has two nice features. First, if there’s no dispute, the buyer and seller can settle without involving the third party. Second, the third party cannot run away with the money as it only holds one key, while two are necessary spend the escrowed funds.

Until now, the escrow conversation has generally stopped here. But in our paper we ask several further important questions. To start, there are privacy concerns. Unless the escrow protocol is carefully designed, anyone observing the blockchain might be able to spot escrow transactions. They might even be able to tell which transactions were disputed, and connect those to specific buyers and sellers.

In a previous paper, we showed that using multisignatures to split control over a wallet leads to major privacy leaks, and we advocated using threshold signatures instead of multisignatures. It turns out that using multisignatures for escrow has similar negative privacy implications. While using 2-of-3 threshold signatures instead of multisignatures would solve the privacy problem, it would introduce other undesirable features in the context of escrow as we explain in the paper.

Moreover, the naive escrow protocol above has a gaping security flaw: even though the third party cannot steal the money, it can refuse to mediate any disputes and thus keep the money locked up.

In addition to these privacy and security requirements, we study group escrow. In such a system, the transacting parties may choose multiple third parties from among a set of escrow service providers and have them mediate disputes by majority vote. Again, we analyze both the privacy and the security of the resulting schemes, as well as the details of group formation and communication.

Our goal in this paper is not to provide a definitive set of requirements for escrow services. We spoke with many Bitcoin escrow companies in the course of our research — it’s a surprisingly active space — and realized that there is no single set of properties that works for every use-case. For example, we’ve looked at privacy as a desirable property so far, but buyers may instead want to be able to examine the blockchain and identify how often a given seller was involved in disputes. In our paper, we present a toolbox of escrow protocols as well as a framework for evaluating them, so that anyone can choose the protocol that best fits their needs and be fully aware of the security and privacy implications of that choice.

Freedom to Tinker is hosted by Princeton's Center for Information Technology Policy, a research center that studies digital technologies in public life. Here you'll find comment and analysis from the digital frontier, written by the Center's faculty, students, and friends.